Understanding income tax as a freelancer

Imagine sliding into your home office with comfy pants, a notebook, and the aroma of coffee.

Working for yourself certainly seems appealing. But, unlike those working for a company, you will have the added responsibility of taking care of your income tax. Freelancers receive a variety of payments throughout the year and, in addition to their core profession, they need to act as an accountant to balance their books.

For the inexperienced, this may be daunting.

“I often find that those who are self-employed don’t understand tax legislation and, if that’s the case, I would recommend appointing both an accountant and a financial advisor,” says Peter Hewett, managing director of Hewett Wealth.

It’s nonetheless important to understand certain things regarding income tax.

Understanding income tax as a freelancer 

Tip: Use our tax calculator to work out how much you owe SARS.

Tax deductions and a retirement annuity

According to Hewett freelancers and any other taxpayers for that matter, are permitted to deduct retirement annuity contributions of up to 27.5% of their taxable income or remuneration annually, up to a maximum of R350,000.

“Let’s say, for example, a freelancer earns R1 million a year. They invoice for expenses of R500,000, such as their office expenses, marketing, and travel costs, and they’re left with R500,000 in taxable profit,” says Hewett. 

As a sole proprietor, this profit is taxable in their name. They can then contribute 27.5% to a retirement annuity (RA), which would be R137,500 of the R500,000, and it would be fully deductible from their income for tax purposes.

On this taxable income, before contributing to the retirement annuity, they would have paid R115,824 in tax, yet after making this contribution, their total tax would drop to R68,722 (assuming they were a natural person below the age of 65), thus saving R47,102. This means they are actually only putting in R90,398 into their RA, but they are getting R137,500 worth of savings and growth on the full allocation.

Hewett explains there are two ways freelancers can make use of an RA:

• They can estimate their annual income (based on previous years and/or projections for the coming year) and allocate a fixed amount every month to an RA. Shortly before the end of the tax year (normally January each year, since personal tax is due at the end of February), they can calculate the maximum contribution, which is 27.5% of taxable income or R350,000 (whichever is the lesser), and then make an annual top-up.
• Alternatively, they can put aside a specific percentage (within affordability constraints) of their monthly income but only allocate it to an RA at the end of each year. This will allow them to create a fund to manage cash flows within the business until the end of each tax year. It also provides more flexibility in terms of which months can accommodate the cash flow required to allocate funds to savings.

“The benefit of the monthly contribution is that you would achieve Rand Cost Averaging on your contributions, while the second option provides more flexibility where cash flows are more volatile,” says Hewett.

Which documents should freelancers keep?

Should freelancers keep every receipt they receive, or are some receipts more important than others?

Hewett believes it’s critical to keep records of all income and expenditures.

“You should have a voucher for every entry on your bank statement,” he says. “I often propose that sole proprietors separate personal and business expenditure by using their debit card for personal expenses and their credit card for business expenses – that way there is a clear accounting record.”

However, Hewett points out that once a business grows, it’s better to run it as a separate, private company because the company tax rate is low compared to the maximum marginal rates for individuals. This enables the management of business finances separately from the freelancer’s own finances. It also provides various other benefits, such as protection against creditors under certain circumstances.  

“All expenses incurred in order to generate an income (generally speaking) are deductible for tax purposes – this includes travel expenses, entertainment expenses, marketing expenses, depreciation of various business assets, and a host of others,” says Hewett.

He urges freelancers to see a certified financial planner as soon as they start earning a taxable income.

Fact or Fiction: Do freelancers pay more taxes?

Rumour has it that freelancers are liable to pay higher taxes than those who work within companies. However, Hewett insists that this shouldn’t be the case as the tax laws apply equally to every South African citizen.

“Many individuals do not appoint specialists to manage their finances, which means they don’t utilise all of the permissible deductions and tax incentives that are in place. Therefore, they often unnecessarily overpay taxes,” says Hewett.

“It is critical to appoint an appropriately qualified tax practitioner and a financial advisor. Make sure you check their credentials, qualifications, and registration with recognised professional bodies,” he adds.

READ MORE: Tax on your retirement annuity: How much does the government take?

Apps to help freelancers with tax

Nowadays there are a variety of online and mobile apps that can be used to help freelancers understand and calculate their taxes. These apps can be particularly useful to freelancers who need to be clued up on these matters.

• hApp-e-tax: This offers everything accountants, auditors, tax practitioners, lawyers, those in business, and students need to know about South African income tax legislation. It offers the core information related to the legislation and makes tax information easily accessible.
• Journey Organizer (JO): This app helps you keep track of your travel expenses so that you can claim a tax deduction at the right time of year.

“As a freelancer, if you incur travel expenses as a result of the income you generate, you can claim a tax deduction – as long as you submit a properly completed and accurate travel logbook to justify your mileage,” explains Steve Easton, CEO of Sanji Security Systems, the company that sells the Journey Organizer app.

“Without a logbook, you will not be able to claim a travel deduction. Recording your business mileage can be done effortlessly with a JO device and apps that help keep track of your mileage, ensuring that you improve your tax efficiency and savings,” he adds.